- Jason Land, REALTOR®
It’s no secret that the Federal Reserve has been increasing interest rates in 2022. It began with a quarter point increase in March and a half point increase in May. In June, the Federal Reserve raised its benchmark interest rate by three quarters of a percentage point - the largest rate hike since 1994.
The rate hikes are a result of the Federal Reserve looking to curb inflation. By raising interest rates, the Federal Reserve is hoping to cool off consumer demand, which has been overwhelming supply - which, in turn, has been driving up prices of consumer goods (gas, groceries, automobiles, etc.) in recent months.
While it’s important to recognize that the Federal Reserve does not directly set the interest rate borrowers pay on mortgages, the Fed’s rate increases will have an immediate and direct effect on rates for short-term lending programs like auto loans, student loans, personal loans, and credit card debt. Mortgage rate increases, on the other hand, are the result of lending institutions recognizing that rising inflation risks eroding the buying power of the dollar. Because banks prefer not to make long term loans if they are getting paid back with money that has less value than it did when they initially lent it. As a result, lenders look into their crystal ball to forecast how rising inflation will affect the future strength of the dollar and, based on this forecast, they will set mortgage rates to ensure they are getting repaid in enough dollars to hedge against the rising inflation.
There have been a lot of things written and said in recent weeks about how rising interest rates will affect home Buyers, and while it’s important to understand the result of rising interest rates on the home Buyer, it’s also important to understand how the home Seller may be affected by these external forces.
First, it’s important to realize that home prices since the year 2000 have been on a steady increase. Since 2020, just after a slight downturn in home prices at the beginning of the COVID pandemic, home prices have soared and homeowners have seen a 33% return on their investment in just two years! [Illustration 1]
Illustration 1
This dramatic increase in home prices during the pandemic was due, in large part, to record low interest rates, a pandemic related rise in demand for home offices and single-family homes, and building supply constraints and cost increases.
In the second quarter of 2020, right in the midst of the pandemic, the 30-year mortgage rate was 2.94%. At the time of this writing, the 30-year mortgage interest rate is 5.81%. [Illustration 2]
Illustration 2
To better understand how this impacts the Buyer, in the fourth quarter of 2020, when the median home price was about $358,700 and the 30-year interest rate was hovering around 2.94%, a home buyer could expect a monthly mortgage payment to be around $1,680. If we consider that today’s median home price has risen to about $428,700, and the rate on a 30-year mortgage is around 5.81%, we see an increase in the monthly payment of around $1,000 to $2,587.
While this potentially means a substantial impact to the Buyer’s wallet and purchasing power, it should be noted that mortgage rates are still far from record highs. You would have to look as far back as October 1981 to see the 40 year high rate of 18.63%.
Mortage rates are still far from record highs
The run up in both home pricing and mortgage interest rates is causing home Buyers to go to some pretty extreme measures just to get into the game. In fact, according to the National Association of REALTORS®, in February 2022, 23% of Buyers waived the home inspection contingency. That’s up from 20% the previous month. And 28% of cash Buyers waived an appraisal contingency.
There is much more demand for homes than there is supply. A year ago, in June of 2021, 56% of homes sold above the asking price. While that number has decreased slightly to just 42% of homes selling above the asking price in February, it’s still clear that Buyers continue to compete - and compete aggressively - for homes.
| "Fixed mortgage rates have increased by more than two full percentage points since the beginning of the year," said Sam Khater, Freddie Mac's chief economist, in a statement. "The combination of rising rates and high home prices is the likely driver of recent declines in existing home sales. However, in reality, many potential homebuyers are still interested in purchasing a home, keeping the market competitive but leveling off the last two years of red-hot activity." |
As a home Seller, you may consider putting yourself in the Buyer’s shoes. If, for instance, you believe mortgage interest rates are going to be higher in six months than they are now, what might you do? If you had already been planning to buy a home, and had been planning to do so within the next year, you might consider accelerating that move and planning to buy in the next six months, instead. As more home buyers are now trying to accelerate their home purchase in order to stave off the impact of inflation and rising mortgage interest rates, this continues to apply pressure in the housing market. At the same time, there continues to be a lack of housing supply, further contributing to the demand.
In the 1980s, mortgage rates were as high as 18%, yet Americans still bought homes. In the 1990s, rates of 8% and 9% were common, yet Americans still bought homes. According to economists, rising mortgage rates generally have little impact on home sales because life events - the birth of a child, marriage, job change - don’t always correspond with mortgage rates.
As a Seller, recognize the historic gains you’ve captured over the last two years. Recognize that in some cities rents have increased by more than 40% within the last year, causing many more renters to consider buying a home instead of renting. Recognize that, by some estimates, the U.S. is still more than 3 million homes short of demand. Recognize that Buyers are now, more than ever, motivated to enter the home buying process, or else risk seeing their purchasing power erode as a result of inflation and higher mortgage rates. Together, these factors, and others previously mentioned in this article, will cause home prices to continue to increase. Perhaps the increase will be at a slower rate, however, I predict they will not fall as a direct response to recent Federal Reserve rate increases.
What do you think about recent rate hikes by the Federal Reserve? As a home Buyer, how have recent mortgage rate increases affected your plans to purchase a home? As a home Seller, are you still worried about selling your home with mortgage rates on the rise? We'd love to hear your feedback in the comments section below.
| “The housing market is starting to feel the impact of sharply rising mortgage rates and higher inflation taking a hit on purchasing power,” says Lawrence Yun, National Association of REALTOR’s chief economist. “Still, homes are selling rapidly, and home price gains remain in the double-digits.” |
